2015-08-14

China Buys Gold in July

Putting what China has just done in very simple context: China announces an increase in its gold holdings of over 58% in the past two months... and then this past week it devalues its currency by nearly 5% in just three days.

Even the most brainwashed Keynesians should be able to figure out what is going on by now.

One wonders how long until millions of Chinese citizens, badly burned on the stock market bubble, decide it is time to put their savings in gold once again.

This will also surprise market traders who think that a continuing collapse in Chinese stock markets will force liquidation of gold holdings by the Chinese public. There is little doubt that distressed speculators will come under pressure to sell gold if they own it, but this argument ignores the certainty that during a credit contraction government-issued currencies always weaken against gold. So having acquired substantial quantities of gold for itself and having also ensured it is widely held by its public, the Chinese government is arguably in a more compelling position to encourage a gold revaluation as a means of stabilising her economy in a credit crisis than America was eighty years ago. It will be China's only option, and if the government doesn't go for it, China's middle classes certainly will.

We are already seeing the People's Bank of China engaging in reflationary policies to contain the stock market crash. This is a normal central bank response. Doubtless it will maintain the managed peg against the US dollar, partly because China is committed to building confidence in her own currency as a replacement for the dollar in international settlements, and partly because currency devaluation would be seen in the markets as a failure of economic policy. Furthermore, China can reasonably expect US monetary policy to do some of its reflationary work for it.

Therefore, instead of devaluing against the dollar, a rise in the yuan gold price is almost certain to occur.

China doesn't have to announce a target price. If the PBOC continues buying gold and encourages the Chinese public to buy an asset rising in price, market forces will do the rest.